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What is an annuity anyway? How can an annuity help me prepare for retirement?

Although you may have heard the term “annuity” a lot recently, you may not be exactly sure what they are. But don’t worry, you’re not alone! While annuities might seem confusing at first, they’re actually fairly easy to understand.

And they’re worth learning about because annuities are becoming increasingly common among people who are developing a plan for their retirement and who want to ensure they will not outlive their savings.

But let’s start with the most obvious question:

What is an annuity?

An annuity is a contract issued by an insurance company that guarantees you a steady stream of payments in the future – most likely during your retirement. In that sense, it’s kind of like a pension plan that you sign-up for yourself.

Why would someone get an annuity?

One of the most common reasons someone might choose to purchase an annuity is if they believe there is a chance they might outlive their retirement savings. Running out of money during retirement would obviously be a very scary situation for anyone!

Also read: Investing 101 for young adults: The basics

Annuities are designed to protect you from this risk. They do this by providing you with income payments that can be guaranteed1 for your entire lifetime. Basically, this means you can depend on regular monthly payments during your entire retirement without ever having to worry about running out of money.

An annuity may also be an appealing choice for people who do not have an adequate retirement benefit or pension plan through their employer, or for people concerned about the amount of government assistance that will be available to seniors by the time they actually retire.

What are the different types of annuities?

There are many different types of annuities, but they all have fairly simple definitions. Let’s run through a few of the most common types!

1. Immediate annuities

An immediate annuity is purchased with a single lump-sum payment and is designed to start providing you with a stream of regular income payments quickly (typically within 30 days). People who choose an immediate annuity are likely close to retirement or may already be retired.

2. Deferred annuities

Unlike an immediate annuity, a deferred annuity is for people who are planning for a retirement in the distant future and aren’t ready to start receiving payments.

You can build the value of your deferred annuity by making regular, smaller payments or with a single, lump-sum payment. It’s up to you. Your investment will then grow (tax-deferred), until you’re ready to start receiving payments.

Also read: Procrastination solutions: Start investing like an adult!

3. Fixed annuities

Fixed annuities provide a guaranteed rate of return for a set period of time. The rate is determined by the life insurance company. A fixed annuity might be right for you if you have a low risk tolerance or a very specific savings goal in mind. A fixed annuity might also make sense if you will be retiring sooner than later and don’t have time for your investments to recover from dips in the market.

4. Variable annuities

Unlike fixed annuities, variable annuities offer investment choices whose values will fluctuate over time. This means that the return you will get on a variable annuity is determined by the performance of those investment choices.

Your agent or advisor will be able to help you decide between a fixed or variable annuity by discussing your financial goals, your risk tolerance and when you plan to start receiving payments from your annuity.

5. Single payment annuities

A single payment annuity is purchased with a single lump-sum payment. This means that the funding of your annuity is achieved with one payment.

6. Flexible payment annuities

Conversely, flexible payment annuities are purchased with multiple payments. The schedule for making these payments is flexible.

What are the advantages of having an annuity?

Along with the peace of mind that comes with making an annuity part of your retirement plan, there are a couple of other major advantages. The first has to do with taxes:

Tax-deferred advantage of annuities

One of the primary advantages of annuities is that they are tax-deferred, which means that you won’t pay income taxes on the gains of your annuity until you begin withdrawing your money. Since many people will wait until retirement to begin receiving payments from their annuity, their money will have many years to grow tax-free and take advantage of compound interest!

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This means that the value of a tax-deferred annuity could grow faster than a taxable investment earning the same return.

Guaranteed death benefit

Another major advantage of an annuity is the guaranteed death benefit. The death benefit helps protect your beneficiary by guaranteeing that they will never receive less than the amount you contribute to your contract (less any withdrawals you make) even if the balance declines because of market fluctuations. Any assets remaining in your annuity (minus withdrawals and fees) can be paid directly to your named beneficiaries.

Getting an annuity

If you think you might be interested in getting an annuity or you simply just have more questions about planning your retirement, you can easily contact an agent or advisor from Foresters Financial™ to get a free assessment of your needs. Remember when it comes to annuities there are no dumb questions!

Want to get even more information on annuities? Check out our annuities homepage to learn more!

Also read: Searching for your soul mate (financial advisor edition!)

1 All guarantees are subject to the financial strength and claims-paying ability of Foresters Life Insurance and Annuity Company.

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Eric Tyndale

Eric has an extensive background in content marketing and professional writing. He loves to write about personal finance and life insurance issues for the Lifenotes blog because he enjoys the challenge of making complicated topics fun for readers! Eric also covers community outreach initiatives.